3.6 Improving conditions for private investment

The existing regime for private investment in Syria, including the agribusiness
sector, has several drawbacks that have so far impeded a more vigorous and sustainable
process of investment and growth. The general problem is that the regime grants
special temporary benefits for new investments, without altering much the general
macroeconomic and institutional environment, or making those benefits permanent.
This encourages the pursuit of short-term advantages, but hardly promotes long-term
growth.

Granting special benefits is indeed a necessity for the time
being. The existing investment promotion regime in Syria was enacted without
major modifications of the basic centrally planned system developed during the
1960s and 1970s. In the 1980s and 1990s a gradual process of liberalization
started, but its progress has been partial, and with alternating and
unpredictable shifts between accelerating and putting the brakes on economic
reform. Thus, uncertainty is still present, and the economic system is afflicted
by many shortcomings. Therefore, apart from the need of proceeding with economic
reform, securing sustainable growth in Syria still calls also for a substantial
amount of specific policies for promotion of private investment.

The various Investment Promotion Decrees and Laws (from 1981
to 2000) gave investors a number of temporary privileges, such as import
licenses or tax exemptions, in an effort to make the investment projects look
more profitable, in spite of the shortcomings of the overall system. These
policies had two major defects:

The advantages in
the promotion policy were mostly temporary; and

Direct promotion was strong,
but macro reforms were weaker

The benefits granted were temporary. This is generally thought
to be correct as regards special privileges such as tax exemptions, but
long-term projects should be viable even after the privileges are removed. A
deadline for the benefits means that after a certain number of years the private
companies would have to operate in the same rigidly controlled environment of a
centrally planned economy, with heavy explicit or implicit taxation and
restriction of private economic activity, and then much of their initial
profitability may disappear. This important limitation of the policy option
chosen by Syria in the 1980s and 1990s severely affected the nature and extent
of the projects. If the rigidities were meant to remain in place, it would not
be wise to encourage investments that are only profitable if rigidities are
removed or investors are exempted from their consequences. Investors, under
those conditions, would prefer projects that yield most of their profit in the
very first years, disregarding long-term growth, and this would be a very
negative feature with grave implications for Syrian economic
development.

Under such an arrangement, a rational businessman would look
for immediate advantages to be obtained during the period of construction and
tax exemption, disregarding long-term gains because, in the long term, the
company would have to work in a centrally planned economy that may be supposed
to be hostile to private investments. This tends to stimulate investments that
aim at reaping most of their profits within the period of exemption or tax
holiday, and less incentives to develop extended business plans for the
long term. There might be investments, but their long-term impact on growth and
employment would be very limited. Investment and growth created by a purely
specific policy of direct promotion with temporary benefits tend to be spasmodic
and not sustainable.

That has been in fact the case. In spite of liberalization
measures starting as early as 1981, the Syrian economy has had nearly zero net
per capita growth in 1980-1999. There has been growth in the 1990s, much of it
due to private investment and the Investment Law, but in ten years it has not
been sufficient to offset and overcome the decline of the 1980s. Many projects
were abandoned, the sustainability of projects after the expiry of tax holidays
is problematic, many companies are not utilizing their full capacity, and the
subsistence of macro impediments for private economic activity hinders the
enterprises in manifold ways. The employment impact of the projects licensed
under the Investment Promotion Law was extremely small. Since the benefits were
concentrated on favouring imports of machinery, capital investment per worker
tended to be higher than expected for an economy like Syria, thus defeating the
purpose of creating employment. Excessive reliance on capital-intensive
technologies, apart from not creating employment, means probably that excessive
resources are used for the investments when more production could be obtained
with less capital. It may also create conditions for an excessive flow of profit
remittances and capital repatriations in the future.

Although the resulting growth of the private sector in
manufacturing and transportation has had many positive effects in the Syrian
economy, much more would be needed to spark sustainable growth in output, income
and employment. Something can be achieved by modifying some stipulations in the
Investment Law, but even that would not be enough. The missing element is deeper
and wider change at the macro level. Unless major institutional and
macroeconomic reforms are enacted, the operation of an investment promotion
regime is not enough to sustain growth, and may even cause deleterious
effects.

a) Procedural and micro reforms

After examining the workings of the existing regime, and
holding extensive talks with a sample of investors, a number of recommendations
for improving the existing legislation and conditions for private investment can
be proposed.

One of them points to upgrade the autonomy and flexibility of
the Investment Office, transforming it into an autonomous self-financed Agency,
with enlarged functions and governed by a Board of Directors comprising the
existing Investment Council plus representatives of the private sector. Another
major recommendation is simplifying the authorization process for new projects,
eliminating various steps in the procedures. A third recommendation is further
flexibility in legal access to foreign currency at market rates.

One problem faced by many projects was the rigidity of the
five-year term the Law establishes for the tax holiday. It could be extended for
two more years, but even this may not be enough (for instance, some projects
involving olive trees have a maturing period of up to 15 years). Expansions
through reinvestments later in the project life cycle are not explicitly
foreseen in the legislation. To address these and related issues, a
recommendation can be made to replace the time-bound tax holiday by the granting
of tax credits for every investment, made either initially or later. As profits
start accruing, the investor would use available tax credits (determined as a
percentage of previous investments) to fulfill profit tax obligations. This
solution solves at one stroke all problems concerning the different timing of
investments, tax holidays and profits.

Also, it should be recommended that the minimum size of
eligible projects be revised, at least regarding agricultural production
projects, and that priority be given to projects oriented to modernizing farming
production, in view of the urgent need of modernization in the Syrian farming
sector (especially as concerns irrigation equipment).

Other micro reforms and improvements, though not explicitly
involving existing legislation for the promotion of private investment, may also
be recommended. They include the following:

Facilitate access
to land, especially publicly owned land, including the development of industrial
zones provided with all basic services (chiefly electricity and
water).

Facilitate the development of co-operative enterprises for joint development of
farming projects (not necessarily involving joint production, but chiefly joint
input procurement and joint processing and marketing).

Facilitate the development of rural micro-finance institutions to expand the use
of credit in the countryside, and introduce further flexibility in the banking
system to improve credit conditions for private investors.

b) Improving the macro environment

Correcting the shortcomings of existing legislation is
necessary but not sufficient. As long as Syria remains basically committed to a
macroeconomic scenario dominated by state planning and intervention, the
development of private investment cannot but be embryonic and spasmodic.
Continuing its efforts initiated in the late 1980s and during the 1990s, the
Government should complete a number of reforms to completely overhaul the
existing macroeconomic setting of the country.

The macro environment comprises the institutional bases
for a market economy, and adequate economic conditions that favour private
economic activity. Also, it includes a state sector that accomplishes specific
functions, essential for the existence of private investment, as well as for the
existence of society under a market economy.

The institutional requirements for a market economy
comprise:

Protection of
private property. For private companies to compete with each other, they
should have the right to dispose of their property, including intangible assets
and intellectual property, and an effective legal protection of their property
rights.

Economic freedom. Companies should enjoy the free choice of their
economic activity, of their suppliers, and of fixing the prices of their
products or services.

The
rule of law. This requires respect for contracts, a competent and
independent judiciary, and sufficient transparency in the conduct of public
affairs. All contracts should be deemed obligatory to all parties concerned, and
all private or public actors should be held accountable before the
law.

Limited roles of the state. The state has specific functions that it must
accomplish for the market economy to work properly. Most of those essential
functions of the state in a market economy are covered by the following list: to
enforce the law and provide legal security; to ensure the provision of basic
social services and public infrastructure; to promote equity in society; to
regulate certain private activities (especially due to market failures); to
provide a sound monetary system; and to promote competitiveness.

Some of these institutional requirements touch upon the
economic conditions necessary for a market economy to work properly. For
instance, a sound monetary system rests not only upon the institutional
arrangements governing it (such as an independent Central Bank) but also on the
maintenance of basic macroeconomic equilibrium (especially a sound fiscal
balance).

An economic system allowing the market to work properly should
at least secure mobility of resources, adequate incentives, low overhead costs
and predictability.

The mobility of resources can be improved by removing
obstacles to mobility. These obstacles include trade barriers, inadequate
banking system, foreign exchange restrictions, lack of active capital markets,
restrictions to foreign investment, rigidities in the labour market,
restrictions in the land market and restrictions for accessing and exchanging
information.

An adequate banking system is an essential component of a
program to increase the mobility of resources. Without efficient banks no
business can operate, and much less can it prosper and be competitive.

Any set of government policies implies incentives to private
agents, leading them in one direction or another. What counts is not the
intention or wishes of the government, but the actual economic incentives
created by its policies, and the kind of reaction that economic agents can be
expected to have when confronted with such incentives. Taxes and subsidies are
the main forms available to the government to create incentives. However, it is
easy to develop grave distortions by way of ill-conceived taxes or subsidies,
which often achieve the opposite of what was intended.

Taxes should be simple, moderate in size and moderately
progressive. When taxing corporations, they should fall more on fixed assets
than on outcomes. When taxing individuals, they should fall more on idle
resources and consumption than on savings and investment. Taxes should be easily
collected, possibly involving incentives for taxpayers to check on each other,
and avoid pyramidal effects or double taxation.

A simplified tax structure based on a Value Added Tax (VAT)
and income tax should replace the complex collection of specific taxes that
still plagues the Syrian tax structure. Two other categories of tax, which may
stand in the new tax structure, are a tax on fixed registrable assets and of
course customs duties, the latter at a moderate average level and with reduced
dispersion. Price subsidies (e.g. paying wheat producers at prices above
international levels) should be replaced with direct payments to
producers.

Another economic condition of an efficient market economy is
to have low overhead costs. This is achieved through improved basic services
(better roads, better electricity, better telecommunication services) and
through a more efficient and less expensive government. Even if a company is
able to contain costs within its boundaries, it should still be paying the cost
of being in an inefficient country. This country cost increases the cost of all
products, imposes the added cost on domestic consumers, and lowers the
countrys competitiveness in foreign markets.

Finally, a market economy should be predictable. Two main
factors contribute to this: a stable macroeconomic framework (especially after
stability has been maintained for a number of years), and expectations that
future political and social events will have no perturbing effects on the
macroeconomic environment.The latter requires a basic social and
political consensus, so that alternation in power would not mean a radical
departure from existing policy.

The absence of predictability makes investment too risky.
Investors would demand exceptionally high rates of return to accept bringing
capital into the country, or would require exceptional guarantees, that may
prove too heavy for the public budget. Creditors would apply higher rates of
interest to any loans taken by the country's banks, or by the country's public
or private sectors in international financial markets. The difference between
those rates of interest and the rates charged to predictable
countries is a measure of the so-called country risk. Country cost and country
risk, the results respectively of high overhead costs and low predictability,
are the main factors affecting a country economic performance in the world
economy.

The reforms to the macro scenario have had, so far, a
piecemealapproach. They are adopted one by one, in a non-integrated
manner. This creates an unequal economic structure, where some aspects are more
advanced than others, like a person with one foot on the ground floor and
another in the third floor, and thus subject to unbearable strains.

The opposite course of a sweeping and sudden reform of
everything would also be unwise. A country suddenly passing from a centrally
planned economy to a fully deregulated market economy would face disaster and
possibly major social and political upheaval.

Reforms should be gradual but integrated, advancing on all
fronts at once. The following are the main aspects to be included in the process
of reform:

Money
and banking, implying foreign exchange liberalization and currency
convertibility, banking reform, independence of monetary institutions and policy
and development of capital markets; and

Reduction of inefficiencies and overhead costs, implying administrative
reform of the public sector, simplification of administrative procedures, and
improvements in basic infrastructures and services.

(ii) to introduce more initiative and
innovation in the strategic-crop sector in a gradual manner, continuing and
deepening the process of flexibility in agricultural planning that has begun in
recent years. A growing percentage of available land, water, credit and inputs
presently allocated to strategic crops should not be allocated by plan, but on
demand, letting farmers decide on the best allocation of those funds. Some 10
percent of the resources could initially be allocated in this manner, and
gradually progress towards higher percentages.

(iii) to promote foreign investment in
agricultural export products. Foreign capital and technology is needed to expand
production of specific high-quality agricultural products, especially fruit and
vegetables, for export to the EU and other markets.

(iv) to develop improved rural finance;
to improve and diversify sources and modes of financing agricultural activity
and rural industry and marketing; to promote rural micro-finance and the
development of adequate banking techniques to reach small farmers through group
credit at reasonable administrative costs with sustainable rates of interest and
credit conditions; and to promote the gradual upgrade of small producers to the
status of normal bank customers.

(v) to promote marketing of agricultural
products; to promote integration of farmers into vertical commodity chains for
production, processing, domestic marketing and export of selected agricultural
products; and to improve administrative procedures for export, and logistic and
port facilities, for rapid dispatch of perishable commodities to their
destination by ship or air.

(vi) to foster on-farm investment for
modernization of irrigation systems. Modernization of irrigation systems in
Syria involves shifting all gravity and flood systems to pressurized sprinklers
and drip irrigation. Metering water is essential to create incentives for
investing in the modernization of systems. The form of payment for irrigation
should consist of a basic fee for the use of irrigation water, plus penalties of
increasing value for exceeding allotted amounts of water.

To modernize irrigation systems, government policy should
secure credit funds and promote private investment for financing the conversion
of 50 percent of irrigated lands to sprinklers and drip irrigation in ten
years.[39] The cost is about US$120 million per
year, only for new irrigation equipment. Another US$30-40 million per year are
necessary for other related investments: improvements in off-farm irrigation
infrastructure; technical assistance to farms to modernize cultivation systems,
change crop schedules, and learn to access new markets. Upgrading the equipment
is only one step: upgrading the farms and improving the skills of farmers should
follow.

This may be taken also as a general concept for the
modernization of agriculture and agribusiness in Syria. Investment in machines
and infrastructure should not imply neglecting the main sources of economic
innovation and growth, human ingenuity and skills, of which Syrians over many
centuries have shown they have an inexhaustible supply. They only need the right
macroeconomic environment to release those forces and make them work.

[39] In 2001, the Government
decided to modernise the whole irrigated area in only four years. This involves
30 percent in public irrigation schemes and the rest in private schemes (mostly
wells). The recommendation of this report is more moderate, as it is limited to
modernise only 50 percent of the whole irrigated area, and that over a period of
ten years. The goal set by the Government (100 percent in four years) may
necessitate more funds than are currently available, and impose much strain on
the implementing agencies. However, any efforts to accelerate the modernization
of the whole irrigated area are welcome and should be encouraged. The Government
goal may be more realistic if restricted to public irrigation schemes, but this
would not overcome the water constraint. The recommendation in this paper may be
construed as involving all public schemes (30 percent of all irrigated land) and
2/7 of privately irrigated land for a total 50 percent of all irrigated land.
The author is not aware of any data with clear evidence about the distribution
of water losses and inefficiency, but it is highly likely that public schemes,
most of which are gravity driven, involve more waste than private schemes mostly
dependent on underground water.